Introduction
Burn rate is a term that indicates the money "burned" each month, although it can also be expressed over other periods.
As with most metrics, it is important to specify exactly what burn rate refers to:
- GROSS Burn Rate: the total negative cash flow for the month.
- NET Burn Rate: the gross burn rate minus the positive cash flows for the month.
For example, if we have negative cash flows of 50,000 euros and, during the same month, positive cash flows of 30,000 euros, the GROSS Burn Rate will be 50,000 euros and the NET Burn Rate will be 20,000 euros.
It is important to know that, when people talk about burn rate without further clarification, they usually mean NET Burn Rate.
Obviously, when the business is working well, this metric stops making sense, since the NET Burn Rate would be negative as cash in the bank increases every month.
Startup lifetime
Once we know how much cash is spent every month, meaning the NET Burn Rate, we can easily predict how many months the startup has left by dividing the cash in the bank by the amount spent each month.
Knowing the time remaining is a better indicator than looking only at revenue or costs, because those amounts are not always collected or paid immediately.
Calculating the investment required
Burn rate can also be used to approximate the money that will be needed in the future. This is very useful when considering an investment round, since burn rate helps estimate how much money will be needed in each one.
It is quite common for investment rounds to cover at least the next 12 or 18 months, which is more than enough time to reach the next milestone. So, following the previous example, if we wanted an investment round to cover the next 12 months, we would need to raise 240,000 euros: 20,000 euros of burn rate multiplied by 12 months.
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Series: Fundamental Metrics for Startups and SMEs
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